Cyprus tax on deposits could be spark Europe fears

Commentary: Bailout marks explosive new phase in euro crisis

WASHINGTON (MarketWatch) — Cyprus, as we noted in January, promised to be a flashpoint for the euro crisis despite its small size, but Brussels officials have turned it into an explosive situation with their ham-handed efforts to “bail-in” small savers to rescue the country’s troubled banks.

All this, even though the Mediterranean island is the third-smallest economy in the euro zone. To bail out its overextended banks, Cyprus needs rescue funds equal to its annual gross domestic product, but that amount — about $22 billion — should be relatively small potatoes given the $17 trillion economy of the European Union as a whole.

Of the $22 billion needed, the EU is only willing to provide $13 billion, with the rest coming from the deposit tax and other measures.

What complicates the issue is that about a fifth of the deposits in Cypriot banks come from Russia, and German officials in particular have balked at a rescue that bails out these offshore depositors, hinting that some of these funds represent money laundering.

Cyprus has close ties to Russia, the former president was a Communist and Russia helped Cyprus out with a $3.3 billion emergency loan last year.

Cyprus has been split in two since the 1970s in an intractable conflict between the Greek and Turkish communities on the island. Turkish Cypriots in the northern third have declared a separate republic that is recognized only by Turkey, while the seats allotted to Turkish representatives in the Parliament of the Republic of Cyprus that belongs to the European Union remain empty.

In February, Greek Cypriot voters elected Nicos Anastasiades of the right-wing Democratic Rally Party as president to replace the Communist Demetris Christofias, who did not run for re-election.

German Chancellor Angela Merkel made a point of demonstrating support for Anastasiades when she attended a January summit of Europe’s conservative parties, urging Cypriot voters, as she did with Greek voters ahead of their elections last summer, to make the right choice.

Reuters

Nicos Anastasiades was elected president of Cyprus in last month’s vote.

With a more pliable government in place in Cyprus, EU officials proceeded over the past weekend then to hash out bailout terms with the unprecedented “stability tax” on all bank deposits to supplement the $13 billion they had decided was the limit the EU could afford for a Cyprus rescue.

The size of the tax for small depositors — 6.75% for deposits under 100,000 euros — came as a shock to Cypriot officials, who had previously accepted levels of about 3%. At the same time, the Cyprus government did not want to levy a tax of more than 10% on deposits above 100,000 euros for fear of chasing away all those offshore accounts.

As a result, Nicosia is already facing a severe political backlash and a potential bank run, which has forced the government to postpone a vote on the bailout package originally scheduled for Sunday because it was not sure lawmakers would approve it.

Why the Cypriot deposit tax could be a good thing

(4:00)

The Cypriot government has little option but to raise money through a bank deposit levy, but it may also be a good thing, argues Heard on the Street's Simon Nixon. He says taxing the current generation rather than future ones might allow Cyprus to move on more quickly. Photo: AP

Banks were closed in Cyprus Monday for a holiday and are likely to remain closed until Thursday as the government tries to get more acceptable terms for the bailout package.

In the meantime, the rest of Europe was thrown into confusion as the ongoing euro
EURUSD, -0.6405%
crisis entered into truly Orwellian territory of masking misguided policies with words that mean the opposite.

The so-called “stability tax” overturns the concept of deposit insurance that has been the foundation of preserving confidence in banks since the Great Depression and may be the most destabilizing concept the Eurocrats could have come up with.

It marks a new level in the hubris and arrogance of a European officialdom that reveals itself as not only dangerously out of touch but apparently devoid of common sense.

Even if beleaguered politicians in Cyprus wrest better terms out of Brussels, much of the damage has been done. Now that the EU mandarins have shown what they are capable of, it will be hard for them to regain any trust or credibility in the face of future shocks that are bound to come in much bigger countries like Italy and Spain.

Faced with what could have been a relatively minor flashpoint, European officials put a match to the tinder box that is the euro and it is far from certain there won’t be an explosion.

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